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# Technology

Prot maximization

Exercises of Microeconomics
Technology and Prot Maximization (Ch. 1-2 Varian)

## Tramontana Exercises Micro

Technology
Prot maximization

Outline

1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

## Tramontana Exercises Micro

Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Outline

1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

## Tramontana Exercises Micro

Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Exercise 1.2

## What is the elasticity of substitution for the general CES

technology y = a x + a x when a 6= a ?
 / 1
1 1 2 2 1 2

## Let us start by recalling that the elesticity of substitution measures

the curvature of an isoquant and can be calculated as:

TRS d (x /x ) 2 1
=
(x /x ) dTRS
2 1

## or, by using the logarithmic derivative:

d ln(x /x )
2 1
=
d ln |TRS |
Tramontana Exercises Micro
Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Solution

Remember that:
f / x1
TRS =
f / x2

in our case:
1
f 1 1
= ax
+ a2 x2

a x 1
for i = 1, 2
xi
1 1 i i

from which:
a x
!1
TRS = 1 1

a 2 x 2

## Tramontana Exercises Micro

Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Solution

so that:
1
x2 a2 1

= TRS

x1 a1
and taking logs:
x 1 a
!
ln ln |TRS | + ln
2 2
= ,
x1 1 a 1

## and we can apply the denition:

d ln(x /x )
2 1 1
= = .
d ln |TRS | 1
Tramontana Exercises Micro
Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Outline

1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

## Tramontana Exercises Micro

Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Exercise 1.3

f (x) xi
i (x ) =
xi f (x)

a
1
b
2

## Let us rst calculate the partial derivative of the production

function with respect to the factor x : 1

f (x)
= ax1a1 x2b
x1

## Tramontana Exercises Micro

Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Solution

## from which we have that:

f (x) x1 ax x a b

1 (x ) = = 1 2
=a
x1 f (x) xx a
1
b
2

## and with a similar reasoning:

f (x) x2 bx x a b

2 (x ) = = 1 2
= b.
x2 f (x) xx a
1
b
2

## Tramontana Exercises Micro

Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Solution

## Note that the same elasticity can be calculated through the

following alternative denition:
d ln f (x)
i (x ) =
d ln x i

## In our case we have that:

ln f (x ) = ln x x = ln x + ln x
a
1
b
2 1
a b
2

that is
ln f (x ) = a ln x + b ln x
1 2

and nally:
d ln f (x) d ln f (x)
1 (x ) = =a ; 2 (x ) = =b .
d ln x1 d ln x 2

## Tramontana Exercises Micro

Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Outline

1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

## Tramontana Exercises Micro

Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Exercise 1.5

1/
1 2
?

dy (t ) t

e (x) =
dt y =t 1

or:
df (t x) t

e (x) =
dt f (t x) = t 1

## Tramontana Exercises Micro

Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Solution

## For the CES function we have that:

f (t x) = (tx ) + (tx2 ) =t x + x
 1/ 1/
1 1 2

that is:

f (t x) = tf (x).
The CES function exhibits constant returns to scale.
In particular:

df (t x) t dtf (x) t

e (x) = = = 1.
dt f (t x) = t 1
dt tf (x) = t 1

## Tramontana Exercises Micro

Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Solution

## Again, we should obtain the same result by using logarithms.

The elasticity of scale can be written as:

d ln f (t x)

e (x) =
d ln t = t 1

In our case:
1
ln f (tx ) = ln t + ln x + x

1 2

so:

e (x) = 1.

## Tramontana Exercises Micro

Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Outline

1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

## Tramontana Exercises Micro

Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Exercise 1.9

1/
1 2 1 1 2 2

## that we can always

 write this in the form
f (x , x ) = A() bx + (1 b)x
1 2 1
 /
2
. 1

## We need to use some algebraic trick in order to solve the problem.

a + a2
Let us multiply the parameters a and a by = 1:
1
1 2
a 1 + a2

# 1
(a + a )a (a + a )a
"
f (x1 , x2 ) = 1 2 1 x1 + 1 2 2 x2 .
a1 + a2 a1 + a2

## Tramontana Exercises Micro

Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Solution

## Now we can write:

# 1
a a
"
1
f (x , x ) = (a1 + a2 )
1
x + 2
x
1 2
a 1 + a2 1
a 1 + a2 2

a a
and by noting that = 1 we can nally have:
2 1

a 1 + a2 a 1 + a2

f (x , x ) = A() bx + (1 b)x
  1/
1 2 1 2

1 a
where A() = (a + a ) and b = .
1
1 2
a +a 1 2

## Tramontana Exercises Micro

Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Outline

1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

## Tramontana Exercises Micro

Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Exercise 1.11

## For each input requirement set determine if it is regular, monotonic

and/or convex. Assume that the parameters a and b and the
output levels are strictly positive.

## Remember that a input requirement set is regular provided that

V (y ):
closed (it must include its own boundary)
non-empty (each positive level of output can be produced)

## Tramontana Exercises Micro

Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

## (a) V (y ) = {x , x : ax log y , bx log y }

1 2 1 2

This is a case in which the isoquants look like the isoquants of the
Leontief technology.
The main dierence is that output is measured in terms of log y :

## Tramontana Exercises Micro

Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Solution

## As for the Leontie technology, V (y ) is closed, non-empty

(regular), monotonic and convex.

## Tramontana Exercises Micro

Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

## Exercise 1.11 (b)

(b) V (y ) = {x , x : ax + bx y , x > 0}
1 2 1 2 1

## Tramontana Exercises Micro

Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Solution

## It follows that V (y ) is non-empty but not closed, so it is not

regular.
In fact:
you can produce the quantity y with combinations of inputs in
which x is arbitrarily low, but not equal to 0. So the input
1

## requirement set does not contain one of its boundaries.

V (y ) is also monotonic and convex.

## Tramontana Exercises Micro

Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

## Exercise 1.11 (c)

(c) V (y ) = x , x : ax + x x + bx y

1 2 1 1 2 2

## It is immediate to see that in this case V (y ) is regular.

In order to prove monotonicity we must calculate the rst
derivatives:
f (x1 ,x2 )
x1 = a + 2xx21 x2 0
f (x1 ,x2 )
x2 = b + 2xx11 x2 0

so V (y ) is monotonic.

## Tramontana Exercises Micro

Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Solution

## To prove that the isoquants are convex, it is sucient (but not

necessary) to show that the production function is concave.
We need to calculate the Hessian matrix, so we need the second
derivatives:
32 1 1 1
f (x1 ,x2 )
x12
= 14 x1 x2
2
f (x1 ,x2 )
x1 x2 = x2 x2
1
4 1 2

12 12 1 3
f (x1 ,x2 )
x1 x2 = 1
4
x x
1 2
f (x1 ,x2 )
x22
= x2x 2
1
4 1 2

## Tramontana Exercises Micro

Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Solution

## The principal minors are:

3 1
D 1 = 14 x1 2 x22 < 0
D 2 = 16 x1
1
x2 161 x11 x21 = 0
1 1

## so the Hessian matrix is semi-denite negative, the production

function is concave and the input requirement set is convex.

## Tramontana Exercises Micro

Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Outline

1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

## Tramontana Exercises Micro

Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Exercise 2.3

a

## 0 < a < 1 and verify that it is homogeneous and convex in (p , w ).

We know (also from the Example in the text) that the rst-oder
condition is given by:
pax a 1
= w,
while the second-order condition is satised when a 1.
By expliciting x we obtain the factor demand function:
1
w a1
!
x (p , w ) =
ap

## Tramontana Exercises Micro

Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Solution

## The supply function is obtained by putting the factor demand

function into the production function:
a
w a1
!
y (p, w ) = f (x (p, w )) = ,
ap
from which we nally have the prot function:

a 1
w a1 w a1
! !
(p , w ) = py (p , w ) wx (p , w ) = p w .
ap ap
Tramontana Exercises Micro
Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Solution

## Let us prove homogeneity:

a 1
w a1 w a1
! !
(tp , tw ) = tp tw = t (p , w ),
ap ap
then the prot function is homogeneous of degree 1.
In order to prove convexity, it remains useful to see the prot
function as follows:
1 a a 1 1 a
(p , w ) = p 1a w a1 a 1a a 1a = p 1a w a1 (a),
 

## with (a) is strictly positive, provided that 0 < a < 1.

Tramontana Exercises Micro
Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Solution

## The Hessian matrix is dened as:

2 (p , w ) 2 (p , w )

D 2 (p, w ) =
p2 p w
(p , w ) (p , w )

2 2

wp w2

## that in our case is:

2a1 a a 1
p 1a w a1 (1aa)2 p 1a w a1
!
a
(1a)2
= a 1 1 2a (a),
( )2 p 1a w a1
1
a
a
a
(1a)2
p 1a w a1

## Tramontana Exercises Micro

Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Solution

## whose principal minors are:

2a1 a
1 = a
(1a)2
p 1a w a1 (a) > 0 , 2 = 0 .

## So, the Hessian matrix is a positive semidenite matrix and:

(p , w ) is convex in (p , w ).

## Tramontana Exercises Micro

Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Outline

1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

## Tramontana Exercises Micro

Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Exercise 2.4

1 2 1

2

2 2 1 1 1 2

1/ 1.

## Let us note that in logarithms the mentioned elasticity is calculable

as follows:
d ln(w x /w x ) 2 2 1 1
,
d ln(x /x ) 1 2

## but by using the properties of logarithms we have that:

ln(w x /w x ) = [ln(w /w ) + ln(x /x )] .
2 2 1 1 1 2 1 2

## Tramontana Exercises Micro

Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Solution

Therefore,
d ln(w x /w x ) d ln(w /w )
1.
2 2 1 1 1 2
=
d ln(x /x ) 1 2 d ln(x /x )2 1

f
w
|TRS | = x1 1
= ,
f
x2
w 2

## so the formula of the elasticity can be written as:

d ln(w /w ) d ln |TRS |
1 = 1
1 2

d ln(x /x )
2 d ln(x /x )
1 2 1

## Tramontana Exercises Micro

Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Solution

d ln |TRS |
but is the inverse of the elasticity of substitution , so
d ln(x /x )
1 2

1
1

## Tramontana Exercises Micro

Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Outline

1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

## Tramontana Exercises Micro

Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Exercise 2.5

is 1 .

## The elasticty of the factor share with respect to (w /w ) can be 2 1

calculated as follows:
d ln(w x /w x
2 2 1 1 )
.
d ln(w /w )
2 1

## From Exercise 2.4 we know that:

ln(w x /w x ) = [ln(w /w ) + ln(x /x )] ,
2 2 1 1 2 1 2 1

## Tramontana Exercises Micro

Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Solution

so we have that:
d ln(w x /w x ) d [ln(w /w ) + ln(x /x )] d ln(x /x )
= 1
2 2 1 1 2 1 2 1 2 1
= ,
d ln(w /w )
2 1 d ln(w /w ) 2 1 d ln |TRS |
and nally:

d ln(w x /w x )
= 1.
2 2 1 1

d ln(w /w )
2 1

## Tramontana Exercises Micro

Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Outline

1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

## Tramontana Exercises Micro

Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

2

## is normalized to 1. Let w be the price of the x input. We must

have x 0.
(a) What is the rst-order condition for prot maximization if
x > 0?

We know that:
(x ) = f (x ) wx = 20x x 2 wx

## from which we obtain the rst-order condition:

0 (x ) = 20 2x w = 0.

## Tramontana Exercises Micro

Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

## (b) For what values of w will the optimal x be zero?

From the previous point we know that the optimal level of input is
given by:
20 w
x =
2
which is equal to zero provied that:

w = 20
but also if w > 20, in fact the input level cannot be negative.

## Tramontana Exercises Micro

Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

We must solve:
20 w
x = = 10
2
from which:

w = 0.

## Tramontana Exercises Micro

Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

## The factor demand function comes from the rst-order condition by

expliciting x :
20 w w
x= = 10
2 2
but given the physical restriction concerning the non-negativity of
the input's level we should write:

## Tramontana Exercises Micro

Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

## The prot function is a function of prices.

Until now we have:
(x , w ) = 20x x 2 wx = (20 w x )x

w
!2
(w ) = 10 .
2

## Tramontana Exercises Micro

Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

## From the prot function obtained in the previous point we can

easily calculate the derivative:
w 1
! !
0 (w ) = 2 10
2 2
that is:
w
!
(w ) = 10
0
,
2
which is the negative of the factor demand, as we should expect.
Tramontana Exercises Micro